Confused by machines, or spooked by the machine-makers

This New York Times article draws attention to real trends in the financial investments industry but gets completely lost in the smoke around those pushing "machines" and "data".

The trend most concerning to the investments industry is the sustained, large-scale outflow of money from "actively-managed" funds, mutual funds being the biggest category of such. The industry makes loads of money from management fees by promoting the idea that investors are paying for expert stock-picking by star investment analysts. The outflow of funds directly impact the revenues of the investment industry.

A key sentence in the article is: "Mr. Fink [Blackrock's CEO] has become convinced that BlackRock must bet big on the power of machines, be it Aladdin, the firm’s risk management platform, robo-advisers, big data or even artificial intelligence."

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The new game in town is the ETFs, or exchange traded funds. These belong to the category of "passively-managed" funds, for which the investment industry earns no or low fees. ETFs are a type of index funds. But index funds have been around for a long time. John Bogle, of Vanguard, has been a long-time advocate for such funds, since the 1970s! So the only real trend is the waking up of the masses.

But ETFs and index funds are neither "artificial intelligence" nor "big data," as alleged in the quotation above. ETFs and index funds attract passive investors; instead of taking bets on individual stocks (or bonds, etc.), these investors are buying a chunk of the market - they are simply taking advantage of the law of large numbers. They eschew stock-picking. To the extent that computers and machines are involved, they are not introducing intelligence but discipline.

These funds also do not need a lot of "data". They usually track some well-defined market index, e.g. S&P or Nasdaq. They do not try to outsmart the market. So the embrace of ETFs has nothing to do with data or machines.

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There are indeed experiments to use "big data" or "machine intelligence" to run funds - but this is a completely separate topic and trend. The article offers two examples. In one, it is claimed that PhDs are using satellite images of Walmart parking lots to evaluate the health of the Walmart business. (I read this with amusement, since in the old days, one would send low-wage bean-counters to those parking lots and count vehicle flow in and out of them. We called those time-and-motion studies, later operations research.)

In another example, it is said that active managers were fired, "all varieties of computer models are crunched in pursuit of stock picking ideas," and management fees are lowered. Readers might get confused at this juncture: this effort is about averting the active management confidence crisis - has nothing to do with ETFs and index funds, which, as explained above, require no machine intelligence.

The people who design these computer models are cut from the same cloth as the earlier generation of stock-pickers. They believe that investors should pay management fees for their expertise in finding stock picks. When we are told that "machines" are replacing humans, we frequently forget that behind every machine are human faces - the computer scientists who write the code that tells the machines how to pick stocks. By investing in such funds, one is buying the concept of stock-picking; the only difference is who is doing the stock-picking.

The banks are not embracing ETFs or passive investing here. The Big Data and AI talk is about saving active fund management. Ironically, because they are charging lower fees, apparently they value the ability of these "machines" less than those of the previous generation, or believe that the consumers are less willing to pay for such a product.

There is no evidence offered in the article that the funds that make use of "big data" or "artificial intelligence" have a better long-term track record than anything else, nor is there a sudden influx of investor interest in such funds.

tl;dr

The investment industry is facing a revenue crisis as investors move their money into ETFs. This article misleadingly connects ETFs to a different initiative of using Big Data and AI for stock-picking. The latter is an attempt by the investment industry to avert the crisis by restoring trust in active investing and stock-picking, which counters the current trend toward passive investing. There isn't a movement of money into funds using AI or Big Data at this time.